British banking crisis: Toxic system exposed

THE NEAR collapse of Northern Rock bank, accompanied by the most astonishing scenes of panic for generations outside its branches, has serious political implications for Britain and the government of Gordon Brown. This was the first open run on a British bank since 1866. PETER TAAFFE examines some of the key features that led to this crisis and looks ahead at what is to come.

IN 1866, Overend, Gurney and Co, a discount house and a 'banker's bank' second only to the Bank of England, almost brought London's banking system down. It had a reputation for financial 'probity', associated as it was with Quakerism in Norfolk before it became a major bank.

But it became involved in 'ill-judged' speculations on railways, shipbuilding and other ventures. The poor Quakers of 1866 were, it seems, duped by fraudsters and middlemen, including a Greek novelist and a wheeler-dealing Irish parish priest! The bank's directors ended up in the dock for their misdemeanours. They were acquitted but were disgraced.

Northern Rock chiefs have had, by comparison, a light slap on the wrist. Northern Rock is less important in today's financial system than Overend, Gurney and Co was in 1866. Nevertheless its involvement in the sub-prime mortgage market and its risky lending policy is typically witnessed in all stages of a boom cycle of capitalism.

Karl Marx pointed out that credit can extend the life cycle of capitalism beyond its 'natural limits'. But like a piece of elastic, it can only be stretched so far before it breaks. It inevitably spawns what Marx called the "most colossal form of gambling and swindling", which is imbued with the "pleasant character of swindlers".

Hence, during booms, financial crooks like Stavisky in France in the 1930s, Leeson in the Baring Bank catastrophe in the 1990s, and now Applegarth, the Chief Executive Officer of Northern Rock. He paid himself £1.3 million while the house of cards he presided over threatened to crash and with it the savings of thousands who had invested their life savings in many cases in this enterprise.

Northern Rock used depositors' money to speculate in the sub-prime market like many other firms which have gone bust or have threatened to do so in the US. Its recklessness is shown in that in the first six months of last year, net lending grew by 47%. The sub-prime market – lending to 'high risk' borrowers at high rates of interest – accounts for 7-9% of the UK mortgage market.

It also dabbled in the US sub-prime market, which has turned into a slow-motion car crash for the US economy. This market amounts to $1.5 trillion, with an estimated $200 billion "valueless debt" parcelled out and distributed throughout the financial system. This is now described as "toxic" by bankers and financiers.

Moreover, nobody knows where this debt really is. One British financial commentator has compared the task of discovering where this debt is to a Microsoft computer game called 'Minefields'. In the course of the game, if a mistake is made, the 'bomb' goes off. The sub-prime bomb has already exploded with serious consequences for the US economy and globalised capitalism.

Workers pay the price

IN THE real world, this is not a game. Ordinary working-class people pay a big economic price like the million families who have lost their homes already in the US because of the general slowdown in house prices now compounded by the sub-prime catastrophe.

Another one to two million home owners face 'foreclosure' and could be out on the street. There are 200,000 home owners in the US who are in immediate 'dire straits' and face imminent property repossession. In a feature in The Guardian on Cleveland Ohio, one poor black woman faced with increased mortgage payments was shown to be desperately trying to hold onto her house for her family. She was already in a full-time job but was seeking another one which would mean a 16-hour working day!

On the very eve of Northern Rock's collapse, one stockbroker urged his clients to buy its stock: "Load up, get your children, grandmother, your goldfish" to buy. The result was a threat of financial meltdown, more serious than anything we have witnessed in the recent past.

Even the secondary banks crisis of the 1970s, which was largely on the periphery of the banking system, did not result in a breakdown of 'interbank' loans, which was the case this time.

One commentator from a big investment bank wailed to the Financial Times: "What we are seeing now is like a natural disaster. Whole parts of the financial system which we took for granted have stopped working". But these events are not a "natural disaster" or an act of God, they arise from capitalism, an unplanned, blind system which, through the so-called law of 'supply and demand' works anarchistically and behind the backs of society. Its contradictions are dramatically revealed in financial and economic crises.

Contagion

THE FINANCIAL excesses of the past involved 'rocket scientists' in the City employed to devise ever more ingenious 'financial instruments' such as cutting up debt and distributing it blindly throughout the world.

This has now blown up in their faces. The collapse of the sub-prime mortgage market in the US and the crashing of 'hedge funds' – multi-billion dollar betting syndicates – has spilled over into similar collapses in Australia, Germany, France and many other countries. The result has been a worldwide 'credit crunch'. The word credit originates from the Latin 'credo' which means trust. In this financial crisis, trust evaporated and threatens to break down completely.

The Northern Rock events will help to change political consciousness in Britain. It is the equivalent of the Tories' Black Wednesday in 1992, which saw the Tory government and its chancellor Norman Lamont (backed up by his then aide David Cameron) fleeing from the Exchange Rate Mechanism of the European Monetary System. This effectively sealed the political fate of the John Major government and led to New Labour coming to power in 1997.

We have yet to see the political consequences of 'Black Monday' when Alistair Darling was forced to overrule, in effect, the prevarications of Mervyn King and the Bank of England. He underwrote the savings of Northern Rock depositors and by implication, all British banks. This represented not just a technical u-turn but a severe blow against the ideas and practices of the unrestrained, unregulated free market capitalism of the last two decades.

Darling's actions were a form of 'nationalisation' of bank deposits, as even capitalist experts have remarked. It immediately raises the question in the minds of previous victims of financial swindles, why did they not get the same treatment? Expect now a clamour for compensation from the victims of Equitable Life's meltdown in 2000, which Brown refused to intervene in when he was Chancellor of the Exchequer.

What about those swindled out of their life pensions by gangsters like deceased press tycoon Maxwell and other well-heeled captains of industry?

Also, why is it that this government can step in to save depositors and not the thousands of workers thrown on the scrapheap by, for instance, the closure in the recent period of companies such as Rover?

Deregulated capitalism is okay, it seems, when the volcanic eruptions do not break to the surface and wreck the lives of millions. The example of Darling's intervention will be invoked if industries begin to collapse as the result of a recession. As with the railways today, the demand of victims of capitalism will be for nationalisation of failing industries.

This crisis also reflected the massive collapse in the trust of British people in all authority and capitalist institutions. Initially, there was no trust in the banks by depositors; why should they when only the first £2,000 of savings was 100% guaranteed to be paid out?

The government was not initially believed when Darling made his first 'reassuring' statement. "Why should we trust this government when they lied on so many other things such as Iraq?" said a woman interviewed on TV. When this did not work, the government had to take over the 'independent' powers of the 'independent' Bank of England and itself act as the guarantor, the 'lender of last resort'.

Up to this point, the bankers and the capitalist press, particularly the Financial Times, semi-official organ of the City of London, were full of warnings of 'moral hazard'. When the capitalists and their hirelings speak about 'morals', keep your hand on your wallet! 'Moral hazard' is not a lap-dancing club in the City which stockbrokers and financiers are warned to avoid. It is a code for free marketeers' opposition to government bail-outs of firms and industries.

But Darling is now likely to introduce an American-type system in place of the present partial insurance for depositors. So, also, the previously 'unswerving' Mervyn King, Brown, Darling and the government have endorsed 'moral hazard' when faced with the possibility of financial meltdown, by providing facilities of £10 billion for 'interbank transactions'.

US economy

AT THE same time, US interest rates have been cut by a hefty 0.5%, 50 basis points, by Ben Bernanke, US Federal Reserve chairman, to stimulate the US economy when it is heading for recession.

The so-called 'wealth effect', arising from the upsurge in house prices, with home owners using their property like a hole-in-the-wall machine – is running out of steam. In fact, one Yale economist, speaking to the US Congress, feared that "the collapse of home prices might turn out to be the most severe since the Great Depression".

The Center for Responsible Lending has predicted that the foreclosures on sub-prime loans will lead to a cumulative loss of $164 billion (£82 billion) in the value of homes. Investment banks are suggesting the cost to financial institutions could be more than $300 billion.

The present upswing in the US and the world has been fuelled by the consumer boom in the US combined with an investment boom and cheap goods, which have flooded world capitalism from China. Without the maintenance of US consumption, the Atlas of world capitalism, the whole of the world will fall into a recessionary tailspin.

The idea has been raised that the group of countries known as the 'BRICs' (Brazil, Russia, India and China) through increased consumption could provide a lifeline to America. This is an illusion; these countries are ultimately dependent on the growth of the world market as either a provider of commodities (Brazil and Russia), a provider of business services (India), or a cheap-labour manufacturer - China, which jointly powers the world market with the US. If US consumption stalls, so will the factories of China and exports of commodities of other countries.

An even bigger drop in the value of the dollar than has already taken place could also develop. A 'dollar crisis' could now replace – or combine with – a financial crisis.

The main holders of dollar assets, China and Asian capitalism, when they see the value of their reserves diminishing, are likely to sell off a large portion of these in favour of the euro. This has risen to new and crippling heights for European industry, increasing the cost of exports, partly as a consequence of the drop in the dollar. All of this points to a recession in the not-too-distant future.

Following the 1998 Russian crisis, capitalism found an escape hatch through the dotcom bubble, which then crashed in 2000 and resulted in a recession in the US. After this, the increase in asset prices, particularly housing, was the main motive force driving ahead the economies of the US, Britain, Ireland and Spain. The latter two, like Britain, are on the edge of a financial precipice, with house prices set to decline, maybe quite dramatically.

Britain is one of the most, if not the most, exposed economies. The virtual abandonment of developing manufacturing industry means the lion's share of growth comes from financial and business services, which account for almost 30% of GDP.

In the second quarter of 2007, whereas the economy grew by 3.1% as a whole, the City boom and housing market meant that financial and business services grew by more than 5%. Charles Dumas of Lombard Street Research summed up the situation in The Guardian: "Britain is threatened by its position as globalisation's epicentre.

Any seize-up of global financial markets affects London and the British economy more than others. Lower real incomes combined with tight monetary conditions, and the overhang of a very high exchange rate, could hammer growth during 2008."

Election timing

LOOKED AT rationally and viewing future economic prospects in Britain and worldwide, Brown should go for an early election. The immediate aftermath of his 'Black Monday' has not had the same catastrophic effect as yet as Major and Lamont's Black Wednesday.

The Tories, in the midst of economic problems and having just come through an election where they lied about Britain's economic prospects, were pilloried by the British people.

In previous financial crises like 1931, 1967 and 1976, Labour's standing in the polls suffered.

Now, New Labour is a pillar of capitalism. Darling's underwriting of savers' deposits has, it seems from the polls, temporarily assured 'Middle England' of the government's financial 'prudence'. The Tories, moreover, are still marked by their past crimes against the British people, despite the 'smiling diplomacy' of Cameron. But if an election is not held soon, the advantage that Brown has in the polls now will not last.

The floods in the summer were much easier to handle than the sea of debt which threatens to drown the consumer boom in Britain. Once repossessions climb and jobs are lost, the government will be blamed. Brown hesitates, however, because of the volatility in Britain – notwithstanding the polls – that may yet blow up in his face.

He does not want to be seen as 'Gordon the brief' if he is defeated in an election held soon. His tenure of office would then be the shortest since George Canning died in office in 1827. If he delays, then he may be forced to go the whole term until 2010, such are the economic rocks which loom that could imperil his government. Either way, a Brown or Cameron government would not offer economic and social salvation for the British people.

New party needed

At the Labour Party conference in Bournemouth, Brown will knock the last nails into the idea that Labour still somehow represents working-class people. Even Tony Benn now accepts that the emasculation of the trade unions at conference for a spurious 'influence' at the National Policy Forum means the end of Labour as a trade-union based, and therefore working-class, party.

Yet instead of boldly calling, as has Bob Crow, to begin to assemble the forces for a new party, Tony Benn proposes more of the same. Campaigns outside parliament, in effect on single issues, are our only hope now in the vain expectation that this will influence legislators to respond to this pressure. His claim that there are "20 socialist parties outside of the Labour Party" is an excuse for passivity.

It is like the proponents of 'Lib-Labbery' in the Liberal Party at the end of the 19th century who looked down in disdain on the efforts of the Independent Labour Party, of Friedrich Engels and of Keir Hardie to raise the banner of an independent working-class party freed from the coat-tails of the two capitalist parties of the time.

We now have three capitalist parties – New Labour, the Lib Dems and the Tories – and the current economic crisis shows that they offer no way out. If the working class is not to be left politically leaderless then the idea of a new party must be energetically fought for at all levels of the labour movement. Such a party would use the Northern Rock scandal to raise the need for bank nationalisation.

Capitalism will drag millions of working people into an economic and social abyss. Only a socialist democratically planned society can avoid this catastrophe. The instrument to prepare for this is a mass party that will give confidence to working people, firstly by linking the day-to-day struggles to the vision of a new socialist society.

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